Question

What are the distinguishing features of the New Classical Macroeconomics? Discuss two policy implications of the New Classical Macroeconomics.

Answer 1

New Classical Macroeconomics states that a household's consumption in a specified time frame depends on its current income and on the expected income in the future, the rates of interest at which it can lend or borrow. However Keynesian view is different; and states consumer spending is affected with changes in current disposable income.

New Classical Macroeconomics states view the role of expected future cash flows as well as expected future capital cost. But Keynesian views current cash flows to a firm and its current capital cost as the major factor of investment spending

The policy implications of the New Classical Macroeconomics are:

-- Policy Ineffectiveness Proposition: The analysis of new classical macroeconomic states that with flexible prices and wages along with rational expectations, monetary policy, when anticipated in advance, will not impact on the employment and output in the short term. It is termed as policy ineffectiveness proposition. Thus only an unanticipated rise in the money supply will impact the output and employment

--Policy Credibility: The new classical approach makes a presumption that economic agents are rational and hold expectations in regard to what the monetary authority is about to announce and thus are in a position to influences their behaviour. However it is on the policy credibility announcements of monetary authority that create expectations in agents. Therefore it indicates that anticipated (or announced) monetary policy changes will have no impact on employment and output even in the short term provided the policy is credible.